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China: hard or soft landing?

It has been a while since I took a good look at China, but with growing levels of talk in the media and across the markets that China’s debt is running out of control, now is a good time to re-visit this important topic. Is China’s growth miracle near its end?

One of the big ironies relating to China is that while the country’s supporters accuse the West of short-termism, much of its difficulties today relate to short term policies.

China’s major problem right now is debt, and also a remarkable rate of capital formation. Yet this has come about because China’s government initiated policies to promote growth during times of hardship across the rest of the world. In other words, it has done much the same thing that Western governments did during the noughties boom years, which is to say to promote growth by creating debt.

And while China’s government accused the US of debasing its currency via QE, in 2008 China’s own money supply leapt by 30 per cent – or so says the IMF.

As for debt, let this comparison tell you all you really need to know. In 2008 total outstanding credit in China was worth around 130 per cent of GDP. By the end of 2012 this figure was 187 per cent of GDP.

The real issue for China, however, is not so much total debt as the rate at which it has grown. Ditto for investment.

China’s capital penetration per worker is still much lower than in the US. The road network in China is just 63 per cent of the US road network; the railway length network has half the length of the US network yet carries more freight and a much higher number of passengers. So that might suggest that China needs even more investment. On the other hand, China has higher capital stock per capita than Russia, Mexico and Brazil.

So does the level of capital stock suggest a bubble or merely that China is more likely to make the transition from middle income to advanced country than most other emerging markets? There may be truth in both sides. Too much growth can create misallocation of resources, and a painful adjustment process may follow. The capital legacy that is left, however, may provide the foundations for growth even when China has reached middle income status.

Now let’s take a look at the here and now. Recent surveys suggest China is seeing a pick-up. Purchasing Managers’ Indices, and data on electricity output, freight and cargo, all point to growth increasing to around 7.5 per cent this year. That is less than the level China has been enjoying. Nonetheless it is far too high to suggest China is suffering a hard landing.

On the other hand, the pick-up has been bought by more debt, and more investment. In Q1 investment contributed 5.9 percentage points to GDP growth, consumption just 2.5 (from 4.3 percentage points in Q1).

Let me finish with two reasons to be bullish and one to be bearish.

First bull point: wages are still growing – migrant wage growth recently rose from 9.5 per cent to 10.5 per cent. McKinsey forecasts that wages for urban workers aged between 15 and 59 will double between now and 2022.

Second bull point: education. The key here is what is known as the PISA test, which is a method of evaluating education around the world by focusing on numeracy, literacy and science skills. Within Shanghai the results are superb, and although we don’t have data on how China is performing overall, anecdotal evidence suggests it is closing the gap with the West very rapidly.

One bear point: population. The UN estimates that the population of Chinese aged between 15 and 59 will decline by WHAT per cent between 2010 and 2030. Then there is the so-called Lewis Turning Point (LTP), which is meant to denote the point when a country runs out of workers to migrate into urban areas. The IMF recently said: “The reserve of unemployed and underemployed workers (which is currently in the range of 150 million)—will fall to about 30 million by 2020 and the LTP will be crossed between 2020 and 2025.”

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

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